Fed Leaves Rates Unchanged; Slashes Projections for Future Hikes

By Amey Stone

Not only did members of the Federal Open Market Committee vote to keep interest rates at the same level, but they dialed back their projections for where rates are headed in the future. Instead of four rate hikes this year, their so-called dot plot indicates just two rate hikes this year.

“I’m not surprised they didn’t hike rates,” says Jim Caron, a fixed-income portfolio manager at Morgan Stanley Investment Management, “but what is very surprising is the accomodative signals they sent to the market.” The Fed raised the short-term fed funds rate it controls to a range of 0.25% to 0.5% at its December, 2015 meeting. It was the first rate hike in nine years and coincided with an increase in global market volatility.

“I really do believe that the sting of markets in early 2016 is very fresh in their minds,” says James Camp of Eagle Asset Management.

After Wednesday’s more dovish statement, Treasuries and stocks rallied and the dollar fell. The yield on the benchmark 10-year note closed near 1.91% from 1.99% just before the release.

The FOMC continues to promise it will closely monitor economic data – as well as international events — before raising rates again. “Global economic and financial developments” are a particular concern. Here’s a key phrase from the policy statement:

The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. However, global economic and financial developments continue to pose risks.

Investors were braced for a more hawkish Fed statement since many recent economic reports had been stronger than expected. Just Wednesday morning, the core rate of consumer inflation posted a 2.3% annual increase.

Yet, “The main message from the Fed today is that it is too early to worry about inflation,” Torsten Slok of Deutsche Bank Securities wrote to clients. In the press conference, Fed Chair Janet Yellen said the committee didn’t expect inflation to meet its 2% target until 2018.

Here’s the main passage discussing inflation in the Fed’s policy statement:

Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

“The text of the statement is hardly hawkish and rather more balanced than we anticipated,” noted David Ader of CRT Capital.

We believe that the market’s baseline was for a drop of just more than 25bp for the 2016 and 2017 periods and 12.5bp cuts for 2018 and Longer-Term rates. Given that, the actual dotplot cut was 50bp in 2016 and 2016 and 1 full cut in 2018 and LT, that should be bullish for the front-end and belly.

Treasuries also rallied at the short end of the yield curve, indicating that investors are dialing back on their rate hike expectations. As of 2:30, fed funds futures were pricing in the odds of a hike by June at 46% down from 64% earlier Wednesday, points out Peter Boockvar of The Lindsey Group. He warns in his note to clients:

What is now going to happen unfortunately IF the trends in the labor market and inflation stats continue is the bond market is going to tighten for them and that would not be a pretty place for them to respond from.

But many strategists think it’s appropriate for the Fed to err on the dovish side. Putri Pascualy, credit strategist for PAAMCO told Barrons: “Unless the U.S. data is so uniformly strong with both China and Europe going in the same direction, I think the rate hike path is going to be low and slow for the rest of this year.”

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There are 3 comments

MARCH 16, 2016 2:50 P.M.

Anonymous wrote:

The Fed can't raise rates. And if they do, it is done with the sole purpose to give the impression everything is just fine and dandy. They will have no choice but to reverse rates in short order. Raising the rate will be short lived and simply will be the last ditch attempt at kicking the can down the road. The Fed is flat out of options.

MARCH 16, 2016 2:52 P.M.

Anonymous wrote:

The Fed is flat out of options. Any more rate hikes would simply have to be reversed in short order.

MARCH 16, 2016 5:43 P.M.

Anonymous wrote:

“I really do believe that the sting of markets in early 2016 is very fresh in their minds,”

So true!

During the period of the markets' sharp decline in January plus roughly first half of February, I was wondering if the Fed chair had wet her pants. I certainly did myself.

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.